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Today we'll take a closer look at Cognizant Technology Solutions Corporation (NASDAQ:CTSH) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
With only a two-year payment history, and a 1.3% yield, investors probably think Cognizant Technology Solutions is not much of a dividend stock. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. The company also bought back stock during the year, equivalent to approximately 4.4% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying Cognizant Technology Solutions for its dividend - read on to learn more.
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Cognizant Technology Solutions paid out 23% of its profit as dividends. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Cognizant Technology Solutions's cash payout ratio last year was 22%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's positive to see that Cognizant Technology Solutions's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was US$0.60 in 2017, compared to US$0.80 last year. Dividends per share have grown at approximately 15% per year over this time.
We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.
Dividend Growth Potential
Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. It's good to see Cognizant Technology Solutions has been growing its earnings per share at 11% a year over the past 5 years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. It's great to see that Cognizant Technology Solutions is paying out a low percentage of its earnings and cash flow. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. All things considered, Cognizant Technology Solutions looks like a strong prospect. At the right valuation, it could be something special.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 28 Cognizant Technology Solutions analysts we track are forecasting continued growth with our free report on analyst estimates for the company.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.